Climb the lithium ladder with Albemarle

While lithium is a somewhat opaque market, Australian operator Pilbara Minerals helpfully publishes the prices suppliers are willing to pay for its spodumene product, which is 6 per cent pure lithium. This has risen from $1,800 (£1,469) a tonne at the end of 2021 to over $4,800 a tonne for the September quarter. That spodumene is then refined into lithium hydroxide, which is then turned into the stuff in lithium-ion batteries. 

Fears of a glut are not overblown, despite the rush to build electric vehicles (EVs). After prices spiked in 2022, there are forecasts for a leaner year in 2023 as new supplies finally arrive. That means there is a chance we are near the top of the market for those selling lithium ore (spodumene) or products one step up the value chain. 

Evidence of the pent-up excitement and volatile prices can be seen in the stock price chart for North Carolina-headquartered Albemarle (US:ALB). Its shares, which hit an all-time high of $325 in November, changed hands for just $72 three years ago. Although the price has recently fallen, the trend is decidedly upward, underpinned by years of investment in in processing capacity and mining output. It is also an established leader in the industry, and handily has a major presence both in China and the US. With the US government keen to build out its own battery capacity and output, this is likely to prove increasingly important.

Figures for the September-end quarter saw adjusted cash profits hit $1.2bn (£1bn) from $217mn a year before, as sales more than doubled to $2.1bn on the back of higher prices and greater volumes. In the space of a year, Albemarle’s output has jumped from 85,000 to 200,000 tonnes of ‘lithium conversion capacity’.

Chief executive Kent Masters said the rise was also helped by the processing timeline, as the lithium sold in the period was mined or bought at least six months earlier, so came in cheap and then was sold very high. But analysts expect strong earnings for some years, and the company is putting its cash flow to good use via further new investments in lithium processing. 

The lithium sector’s sudden rush to boost supply is one of several to have occurred since 2016, whipsawing prices in the process. This time, however, the fundamentals appear more solid, thanks to clear indications from the world’s major carmakers that they are committed to building EV supply chains, meaning they will need much more lithium to hit production targets. 

Near-term price expectations vary. Bernstein forecasts both a drop in spodumene prices and an incoming ‘wall of supply’ in 2023 that will make lithium much more affordable for carmakers. “The demand growth of lithium is immense… we estimate demand will grow at a compound annual growth rate (CAGR) of 16 per cent between now and 2030,” wrote Bob Brackett, an analyst at the investment bank, in an October report. “But supply is also set to grow rapidly — in 2023 alone we anticipate a production increase of 46 per cent. This should bring the market to a surplus, even when taking into account the 2022 deficit and 2023 demand growth.” 

HSBC analyst Santhosh Seshadri is more bullish on prices in 2023, based on forecasts of a 3 to 4 per cent supply shortage. Erring on the pessimistic side, lithium miners could face pressure on both their bottom line and share prices in the coming months, should headline prices start to fall dramatically.

But there is still value further up the supply chain, which is where Albemarle comes in. Albemarle owns a collection of mines and processing plants in South America, Australia, the US and China. It is currently increasing output at its Kemerton operation in Australia and recently bought the Qinzhou plant in China for $200mn. Around 85 per cent of its lithium sales are battery-grade, allowing it to market a more premium product than many peers.

Like any industrial firm exposed to cyclical pressures, the near-term outlook is uncertain. But the broader growth trend works in Albemarle’s favour and its business model helps reduce costs. “While approximately 45 per cent of our costs come from raw materials and services, 20 per cent of those relate to our own spodumene,” explained chief financial officer Scott Tozer on a recent analyst call. While car sales could take a hit from higher interest rates, Tozer thinks EVs’ gains in the total auto market share in 2020 suggest sales will be resilient.

The fact that Albemarle’s share price has risen over the past year speaks to investor optimism in lithium. But compare current pricing with the stock’s valuation for much of 2021 – and a price to forward earnings ratio of as much as 53 – and market sentiment now looks positively dour. What’s more, Albemarle’s shares have risen at a similar rate to those of revenue-less mining hopefuls that still need to raise tens or hundreds of millions of dollars to get to production. Albemarle is already producing, generating billions of dollars of cash, and paying a dividend. The difference between it and other big miners is its processing and beneficiation – its expertise and unique dual exposure to the US and China.

Concern at a growing cleavage between the world’s two superpowers might explain why Albemarle is valued on just eight times forward earnings. For comparison, that’s less than a third of the multiple of speciality chemicals group Croda International (CRDA), a company whose performance technologies arm is trumpeted as enabler of cleaner energy solutions.

Downsides of course exist. Mining always carries execution risk, and the lack of pricing power may be ill-suited to an inflationary environment. But this is a company deeply embedded in the EV supply chain that is already running world-leading midstream assets, trading at a relative low.